How much should pharmacists save for retirement?

One question I get all the time from pharmacists is “How much do I need to save for retirement?” To come up with an answer, I sit down with clients to review their personal situation. I look at things like the client’s income, savings, the number of dependents they have, the year they want to retire etc. Since retirement planning depends on so many variables, I recommend this approach if you want the highest degree of comfort and peace of mind around your retirement planning.

But what about the busy pharmacist who just wants a ballpark answer? Is there a good rule of thumb that pharmacists can use? Some of you may have heard of the “70% replacement rule.” Is that a reliable figure? How about the “10% savings” rule? Does that work?

Luckily , a new study released by the C.D. Howe Institute looks to answer some of these questions. Written by actuary Malcolm Hamilton, the report titled “Do Canadians Save Too Little” provides a rare optimistic view of retirement savings in Canada. The report also provides some useful information that future retirees can use as a savings baseline.

From my experience, much of the anxiety around retirement planning comes from the idea that you need to replace 70 per cent of your income in order to live as comfortably as you did while you were working. According to Mr. Hamilton, the good news is that many people will be just fine with a figure closer to 50 per cent. He notes that the greatest challenge for people “come early in their adult lives when the burdens of acquiring a home and supporting young children strain the family budget. After that, things get easier.”

Mr. Hamilton says replacement targets like the “70% rule” are unreliable measures of retirement income adequacy. That’s because individual goals and circumstances are so diverse, even for workers with similar incomes. Since pharmacist incomes have historically been similar, finding a retirement rule of thumb might seem like a lost cause. However, Mr. Hamilton’s takes a unique approach in his study.

Mr. Hamilton creates a simple set of scenarios to illustrate his points. For pharmacists looking for a ballpark estimate on how much to save for retirement , Mr. Hamilton’s information can provide an excellent starting point.

Meet our couple:

In his report, Mr. Hamilton creates a fictitious couple with the following characteristics:

• They marry at age 25 and remain married throughout their lives.
• Both spouses work and earn $120,000 per year between the ages of 25 and 44.  They earn $140,000 per year between the ages of 45 and 64.
• They buy a $520,000 home at age 30 with a 10 percent down payment and a 25-year mortgage.
• They have twins at age 30 and support them for 20 years.
• They retire at age 65 and live to age 90.

Now the above scenario will not capture all the characteristics of the average pharmacist, but then again no scenario will. Scenarios are not meant to predict the future – they are meant to demonstrate the outcomes of different paths. (Think of it this way: an airplane pilot sees a mountain off in the distance. After seeing the mountain, the pilot knows she needs to change the current flight path to avoid a disaster.)

Using the couple described above, Mr. Hamilton creates five scenarios. Each scenario estimates the amount of disposable income the couple will have during three life stages: their early working years (age 25 to 44), their later working years (age 45 to 64), and retirement (starting at age 65). Disposable income is defined as the money the couple has left over after taxes, savings (if any), childcare costs and mortgages payments.

If the couple saves nothing during their working years, how much income can they expect to receive in retirement? (Strategy #1).

How much income would this couple expect to receive at age 65 if they didn’t save for retirement at all? That means the couple will spend all their disposal income while working, and will only receive government benefits (CPP, OAS) at retirement. Mr. Hamilton estimates the couple would have $50,000 of disposable income per year in period 1, $85,000 in period 2, and their retirement income at age 65 would be $40,000 per year.

Of course most people do not retire with absolutely zero personal savings, but this scenario does illustrate the base retirement income a couple can expect to receive from the government.

How much does the couple need to save annually if they want retirement income that equals the average disposal income they will receive while working? (Strategy #4).

This is the “Goldilocks Scenario” which aims for a retirement income that is “not too low” (like the low disposable income the couple will experience during the early years of high taxes, childcare costs and mortgage payments.) This scenario also results in a retirement income that is “not too high” (like the high disposable income the couple will experience during the years just before retirement when the mortgage is paid off and the children are grown up.)

Mr. Hamilton estimates that if the couple saves about 7.1 percent each year in their RRSPs, they will have a retirement income that is equal to the average disposable income they will have during their working years. That works out to disposal income of $46,000 per year in period 1, $79,000 per year in period 2, and $62,000 per year in retirement. The trade-off here is that disposable income drops 21 percent when the couple retires, but at $62,000, it is still 36 percent higher than in was in period 2.

If the couple delays saving for retirement until age 45, how much will they need to save annually to maintain the disposal income they have just before retirement (Scenario #5)?

In this scenario, the couple saves nothing for retirement from age 25 to 44, then they double their savings efforts at age 45. Mr. Hamilton estimates that if the couple saves 20% of their income each year during the latter part of their working years, they can expect to receive $50,000 in period 1, $67,000 per year in period 2, and $67,000 per year in retirement.

The study has five scenarios in all. Mr. Hamilton also includes a scenario that taps into the home equity the couple has built up. The complete table is included below.

[table] Strategy[attr style=”width:220px”], Income Period 1, Income Period 2, Income Period 3
#1: No Saving, “$50,487″,”$84,982″,”$39,732”
#2: 70 percent Gross Replacement, “$41,586″,”$72,649″,”$82,475”
#3: Fully Replace Final Consumption, “$40,756″,”$71,499″,”$86,151”
#4: Replace Average Lifetime Consumption, “$45,941″,”$78,683″,”$62,312”
#5: Replace Period 2 Consumption by Saving in Period 2, “$50,487″,”$67,445″,”$67,445”
#6: Strategy 5 with Drawdown of Home Equity, “$50,487″,”$75,387″,”$75,387″
[/table] [table] Strategy[attr style=”width:220px”], Replace- ment Ratio (%), RRSP Saving Period 1 (%),RRSP Saving Period 2 (%)
#1: No Saving, 28.6, 0.0, 0.0
#2: 70 percent Gross Replacement, 70.0, 13.8, 13.8
#3: Fully Replace Final Consumption,74.0, 15.1, 15.1
#4: Replace Average Lifetime Consumption,49.3, 7.1, 7.1
#5: Replace Period 2 Consumption by Saving in Period 2, 54.3, 0.0, 19.6
#6: Strategy 5 with Drawdown of Home Equity, 42.4, 0.0, 10.7
[/table]

So which scenario is most relevant to pharmacists?

Again, Malcolm Hamilton’s report will not exactly capture the characteristics of every pharmacist. However, the report does provide some very useful information that pharmacists can use as a guideline.

From my experience, most clients follow a savings pattern that is similar to scenario 5: relatively little (if any) retirement saving is done prior to age 45. After age 45, retirement becomes a priority and saving rates jump to 15 to 25 percent of salary.

The study also looks at the implications of the “70 percent rule.” In order to replace 70 percent of the couple’s gross income during retirement, Mr. Hamilton estimates that the couple will need to save 14% of their income during their entire working lives. This means a low disposable income in period 1 (the couple sacrifices heavily for 20 years) in order to maintain the high standard of living they will experience during the end of their working years.

Conclusion

Like I’ve said before, retirement planning is complicated, so I recommend using a finance professional for those pharmacists who want a high degree of comfort around their retirement planning. This is especially true the closer you get to retirement.  (Using the airplane analogy again, the closer the mountain is to the plane, the less time the pilot has to avoid a disaster. Similarly, the earlier you start planning for retirement, the better chances you will avoid a terrible outcome.)

The Hamilton study is a good tool pharmacists can use to sketch out their golden years.  The good news is that Mr. Hamilton says many Canadians can retire comfortably on around 50 percent of their pre-retirement income.  From my experience, I tend to agree.